Reg. § 1.865-3 Source of gross income from sales of personal property (including inventory property) by a nonresident attributable to an office or other fixed place of business in the United States.
(a) In general Notwithstanding any provision of section through or other regulations in this part, this section provides the sole sourcing rules for gross income, gain, or loss from section sales. Gross income, gain, or loss from a section sale is U.S. source income to the extent that the gross income, gain, or loss is properly allocable to an office or other fixed place of business in the United States under of this section.
(b) Exception for certain inventory sales for use, disposition or consumption outside the United States A section sale does not include any sale of inventory property that is sold for use, disposition, or consumption outside the United States if an office or other fixed place of business of the nonresident in a foreign country materially participates in the sale. See to determine whether a foreign office materially participates in the sale and whether the property was destined for foreign use.
(c) Section 865(e)(2) sales For purposes of this section, a “section sale” is a sale of personal property by a nonresident, including inventory property, other than a sale described in of this section, that is attributable to an office or other fixed place of business in the United States under the principles of section as prescribed in and . In determining whether a nonresident maintains an office or other fixed place of business in the United States, the principles of section as prescribed in apply, including the rules of paragraph (d) of that section regarding the office or other fixed place of business of a dependent agent of the nonresident. For purposes of this section, “inventory property” has the meaning provided in section , and “nonresident” has the meaning provided in section .
(d) Amount of gross income, gain, or loss on sale of personal property properly allocable to a U.S. office
(1) In general Except as otherwise provided in through of this section, the amount of gross income, gain, or loss from a section sale that is properly allocable to an office or other fixed place of business in the United States is determined under the principles of .
(2) Produced inventory property Gross income, gain, or loss from a section sale of inventory property that is produced by the nonresident seller is properly allocable to an office or other fixed place of business in the United States or to production activities in accordance with the “50/50 method” described in of this section. However, in lieu of the 50/50 method, the nonresident seller may elect to allocate the gross income, gain, or loss under the “books and records method” described in of this section, provided that the nonresident satisfies all of the requirements described in of this section to the satisfaction of the Commissioner. Gross income allocable to production activities under this is sourced in accordance with . For purposes of this , the term “produced” includes created, fabricated, manufactured, extracted, processed, cured, and aged, as determined under the principles of (except for ). See section and .
(i) The 50/50 method Fifty percent of the gross income, gain, or loss from a section sale of inventory property that is produced by the nonresident seller is properly allocable to an office or other fixed place of business in the United States, and the remaining 50 percent of the gross income, gain, or loss is properly allocable to production activities (the “50/50 method”).
(ii) Books and records method
(A) Method Subject to of this section, a nonresident may elect to determine the amount of its gross income, gain, or loss from the sale of inventory property produced by the nonresident seller that is properly allocable to production activities and sales activities for the taxable year based upon its books of account (the “books and records method”). The gross income, gain, or loss allocable to sales activities under this method is treated as properly allocable to an office or other fixed place of business in the United States and the remaining gross income, gain, or loss is treated as properly allocable to production activities.
(B) Election and reporting rules
(1) In general A nonresident may not make the election described in of this section unless the requirements of through of this section are satisfied. Once the election is made, the nonresident must continue to satisfy the requirements of through of this section until the election is revoked. If the nonresident fails to satisfy the requirements in through of this section to the satisfaction of the Commissioner, the Commissioner may, in its sole discretion, apply the 50/50 method described in of this section.
(2) Books of account The nonresident must establish that it, in good faith and unaffected by considerations of tax liability, regularly employs in its books of account a detailed allocation of receipts and expenditures that, under the principles of section , clearly reflects both the amount of the nonresident's gross income, gain, or loss from its inventory sales that are attributable to its sales activities, and the amount of its gross income, gain, or loss from its inventory sales that are attributable to its production activities. For purposes of this , section principles apply as if the office or other fixed place of business in the United States were a separate organization, trade, or business (and, thus, a separate controlled taxpayer) from the nonresident (whether or not payments are made between the United States office or other fixed place of business and the nonresident's other offices, and whether or not the nonresident itself would otherwise constitute an organization, trade, or business).
(3) Required records The nonresident must prepare and maintain the records described in of this section, which must be in existence when its return is filed. The nonresident must also prepare an explanation of how the allocation clearly reflects the nonresident's gross income, gain, or loss from production and sales activities under the principles of section . The nonresident must make available the explanation and records of the nonresident (including for the office or other fixed place of business in the United States and the offices or branches that perform the production activities) upon request of the Commissioner, within 30 days, unless some other period is agreed upon between the Commissioner and the nonresident.
(4) Making and revoking the books and records method election; disclosure of election Except as otherwise provided in publications, forms, instructions, or other guidance, a nonresident makes or revokes the election to apply the books and records method by attaching a statement to its original timely filed Federal income tax return (including extensions) providing that it elects, or revokes the election, to apply the books and records method described in of this section. For nonresidents making the election, the statement must provide that the nonresident has prepared the records described in and of this section.
(5) Limitation on revoking the books and records method election Once made, the books and records method election continues until revoked. An election cannot be revoked, without the consent of the Commissioner, for any taxable year beginning within 48 months of the last day of the taxable year for which the election was made.
(3) Purchased inventory property All gross income, gain, or loss from a section sale of inventory property that is both purchased and sold by a nonresident is properly allocable to an office or other fixed place of business in the United States.
(4) Depreciable personal property Gain from a section sale of depreciable personal property (as defined in section ) is allocated under and of this section.
(i) The gain not in excess of the depreciation adjustments, if any, is properly allocable to an office or other fixed place of business in the United States to the same extent that the gain would be allocated to sources within the United States under the rules of section . The remaining gain not in excess of the depreciation adjustments, if any, is allocated to sources without the United States in accordance with section . However, notwithstanding the preceding sentences, if the property was predominantly used in the United States, within the meaning of section , for a particular taxable year, all of the gain not in excess of depreciation for that year is properly allocable to the office or other fixed place of business in the United States.
(ii) The gain in excess of the depreciation adjustments, if any, is treated as if such gain was from the sale of inventory and the amount allocable to an office or fixed place of business in the United States is determined under or of this section, as applicable.
(e) Determination of source of taxable income For rules allocating and apportioning expenses to gross income effectively connected with the conduct of a trade or business of a foreign corporation in the United States (including gross income, gain, or loss sourced under this section), see section . For rules allocating and apportioning expenses to gross income, gain, or loss effectively connected with the conduct of a trade or business of a nonresident alien in the United States (including gross income, gain, or loss sourced under this section), see section .
(f) Export trade corporations This section does not apply for purposes of defining an export trade corporation under section .
(g) Applicability date This section applies to taxable years ending on or after December 23, 2019. However, a nonresident may apply this section in its entirety for taxable years beginning after December 31, 2017, and ending before December 23, 2019, provided that the nonresident and all persons related to the nonresident (within the meaning of section or ) apply this section and , -2(b), 1.863-3, 1.863-8(b)(3)(ii), 1.864-5(a) and (b), and 1.864-6(c)(2) in their entirety for the taxable year, and once applied, the nonresident and all persons related to the nonresident (within the meaning of section or ) continue to apply these regulations in their entirety for all subsequent taxable years.
[T.D. 9921, 85 FR 79851, Dec. 11, 2020]